Let them eat credit and watch our schools fail

There’s a compelling argument that as long as Western politicians could deliver the appearance of higher incomes by expanding access to credit and rising house prices, they stopped doing their homework on the things that deliver sustainable productivity and therefore rising incomes: the hard yards of educational improvement.

Julia Gillard has confirmed that our education system has deteriorated markedly: you can’t even be sure that when you leave your kids at school they will all be learning to read and write. Her grand crusade outlined what’s at stake: rising incomes in the future.

So, what have our politicians been doing for the last 20 years? In Australia we know our educational performance started slipping in the 1990s. What accounts for this neglect of the most essential of government responsibilities?

The best argument for why both sides of politics have failed us in this critical frontier is the “Let them eat credit” account. Income growth is always underpinned by productivity growth. US economist Raghuram Rajan argues that the increased productive capacity of workers achieved in the US in the post-war period through higher standards of education participation and quality at all levels ended in the 1980s. From Reagan on, he explains, successive administrations got lazy. They drifted into the “let them eat credit” formula of government policy: expanding access to credit through government induced no-recourse loans and fully deductible interest on home loans. Add to this low interest rates due to the influx of Chinese yuan and private sector inventiveness of new ways to play with this expanding pool of unproductive capital. The result: a massive housing bubble and a long road to recovery.

Rising house prices allowed voters to think they were getting richer. Real incomes – the only sustainable basis for housing price rises – had actually been stagnant or falling. The new cars, home equity financed renovations, and ever more exotic holidays were not underwritten by rising productivity and incomes. It had all been a mirage. The educational uplift that had defined US post-war economic growth and therefore the social mobility that was its signal accomplishment, had ceased. The real beneficiaries of the beautiful mirage were the politicians relieved of the hard yards of real reform.

How does Australia compare in the “let them eat credit” stakes? Certainly Australian governments steered clear of the worst of the US policy formula. Our far saner prudential requirements and the absence of the distortions that flow from tax deductibility of home loan interest meant we didn’t have a sub-prime crisis.

Australia’s finance sector, however, has been a culprit in our story. Bank of International Settlements chief economist Stephen Cechetti argues that our finance sector is too big and has encouraged indulgence in excessive unproductive credit – oversized housing loans; capital which would otherwise have flowed into more economically productive purposes.

We also suffered from another disease: middle class welfare. Begun under Howard and continued by the Rudd and Gillard governments, the terms of trade dividend delivered by the Chinese hunger for our commodities was returned to Australians as family payments A and B; royalties and tax receipts which could have been invested in productivity improving reform of all levels of education.

With house and now commodity prices coming back down to earth, our reckoning appears to have arrived. Full marks to Gillard for drawing a line in the sand and declaring our most urgent task the creation of an education system capable of underwriting rising incomes in the future. It’s about time. And it’s not just about money; it’s about leadership.

Creating the institutions, as well as markets, to deliver educational uplift from cradle to career and beyond is hard work. Reform and improvement– given the system’s scale, complexity and the intransigence of vested players – are the tasks of the great.

The contest of the best way to do this has begun in earnest. The interests of the few will need to be sacrificed for the good of the nation. It will require creativity as well as raw political bargaining. This is real governance, not the sugar hit of expanding access to credit.

Understanding how we got here is essential to ensure it never happens again. Real income growth that lasts comes from productivity improvement, and education is one of the biggest productivity levers governments have access to. It’s the education system, stupid, and it always will be.

Elena Douglas is convenor of the Centre for Social Impact at the University of WA Business School.